Initial reactions to the SEC climate disclosure rule
The Securities and Exchange Commission’s (SEC) Climate Rule, one of the most anticipated and hotly debated securities regulations to emerge in years, was unveiled in its final version Wednesday and approved in a 3-2 vote.
The final ruling, subject to some 24,000 public comments, looks markedly different from the rules initially proposed in 2022, in what SEC Chair Gary Gensler said was a bid to prioritize decision-useful information for investors and reduce the cost of compliance for issuers.
The Enhancement and Standardization of Climate-Related Disclosures Rule will require registrants to disclose climate-related risks that may have a material impact on the registrant’s business strategy, operations, or financial conditions, as well as activities taken to mitigate or adapt to climate-related risks, including the use, if any, of transition plans, scenario analysis or internal carbon prices.
Companies will also be expected to report on board oversight of climate-related risks and processes for identifying, assessing and managing related risks.
But perhaps the most significant revision in the final ruling is its lighter-than-expected approach towards greenhouse gas (GHG) emissions reporting. While the draft version required Scope 1 and 2 emissions reporting as standard, with Scope 3 emissions reporting required where considered “material,” the final rule exclusively requires large accelerated filers (LAF) and accelerated filers (AF), (with market caps of more than $75 million), to provide Scope 1 and 2 reporting, and only where deemed “material.” Scope 3 emissions, derived from a company’s supply chain, will not form part of the reporting requirements.
“It was a bit of a surprise that Scope 1 and 2 emissions disclosures are now subject to materiality,” Michael Littenberg, partner at law firm Ropes & Gray told Diligent Market Intelligence (DMI) in an interview. “Some weeks ago, I would have expected a flat requirement for that.”
LAFs are required to report on climate risks starting in FY2025 and disclose emissions annually from FY2026 onwards. For AFs, climate risk reporting will begin in FY2026 and emissions reporting in FY2028. Smaller reporting companies (SRC) will be expected to report on climate risks in FY2027 and are exempt from the emissions disclosure requirements.
Approximately 40% of the 7,000 U.S. public companies registered with the SEC would be large enough to qualify for mandatory Scope 1 and 2 emissions reporting.
The general consensus among ESG-focused shareholder advocacy groups is that the rule does not go far enough, but is still a step in the right direction. As You Sow’s Decarbonization Lead, Abigail Paris, described the rule as an “important advancement,” but said allowing companies to determine the materiality of their emissions will create “significant subjectivity, diminishing confidence in reporting.” In an online statement, Sierra Club Executive Director Ben Jealous said the rule “falls significantly short of what's needed.”
The rule also looks set to face legal action from the opposing side of the ESG divide. Within two hours of the rule’s announcement, 10 Republican-led states, including Georgia and Alabama, already moved to challenge the new rule in the 11th U.S. Circuit Court of Appeals.
Regardless of the ruling’s stance on Scope 3, however, investors and other global policymakers seem resolute in their expectation that Scope 3 disclosure should become the new standard. In the time the SEC has taken to finalize the rule, both the EU and California have implemented policies to mandate Scope 3 disclosure. Voluntary standards such as the International Sustainability Standards Board’s (ISSB) framework also encourage Scope 3 reporting.
“The big companies, where most of the carbon is coming from across all three scopes are, in my view, going to adopt the ISSB’s standards on a voluntary basis and the CSRD’s ones as well, if they have to. Both require more than what the SEC came out with,” Robert Eccles, visiting professor of management practice at The University of Oxford, told DMI.
“Many registrants already provide voluntary climate-related disclosures that go well beyond the requirements of the SEC’s new rules,” said Littenberg.
At DMI’s Proxy Season Preview event last month, panelists also emphasized the importance of Scope 3 disclosures. “If there is some hope that companies can declare victory if the SEC cuts out Scope 3, it won't change the investor demand for that data and some jurisdictions somewhere will still require it of you,” said Jake Rascoff, director, climate financial regulation at Ceres.
“We just want to see you are investigating and doing a deep dive on Scope 3, knowing that it's not going to be perfect,” fellow panelist Edward Apsey, co-head of ESG engagement and stewardship at CIBC, said. “If you can put your estimations in a corporate sustainability report and explain how you got there and how you’re looking to improve, that goes a long way in our conversations.”
Shareholder proposals exclusively seeking Scope 3 emissions reporting and/or targets are also becoming more common. In 2023, four proposals of this kind won 14.6% average support, compared to two winning 21.9% support a year prior, according to DMI Voting data.
With Scope 3 emissions estimated to constitute between 65% and 95% of a company’s emissions, understanding supply chain emissions is essential for companies looking to understand the full environmental impact of their business. Companies also need to consider that voluntary disclosure of Scope 3 will demonstrate to shareholders a commitment to sustainability, as well as helping companies discover new ways to optimize processes and unlock cost saving opportunities.
